interest rates to rise

[Stephen1151]

Im no economist but I am wondering how high interest rates will go in the next few years. I always thought that they cant go that high because our dollar will be to strong and hurt exports and manufacturing.

My guess is that a 5 year will move up to around 7% in the next few years

Other ideas are most welcome.

 

[Thomas Beyer]

QUOTE (stephen @ Apr 20 2010, 08:13 PM) Im no economist but I am wondering how high interest rates will go in the next few years. I always thought that they cant go that high because our dollar will be to strong and hurt exports and manufacturing.

My guess is that a 5 year will move up to around 7% in the next few years

Other ideas are most welcome.
2% higher for a 5 year term and 2.5% for prime within 1.5 years .. so about 6% for a 5 year rate and 4.25 to 5% for prime.

If beyond that it will hurt overall consumer spending, the economy and GDP growth !

Not bad .. back to normal !

 

[Stephen1151]

Yes that does sound reasonable...I hope you are right. I do think when I buy again I will stay away from longer term mortgages and stick with 1 or 2 year terms.

 

[Thomas Beyer]

QUOTE (stephen @ Apr 21 2010, 04:23 PM) Yes that does sound reasonable...I hope you are right. I do think when I buy again I will stay away from longer term mortgages and stick with 1 or 2 year terms.
or variable as over the last 40 years variable has ALWAYS been lower than a fixed rate !

And with prime going up we will see LOCs and mortgages at prime - 1% again .. soon !

 

[bizaro86]

QUOTE (ThomasBeyer @ Apr 21 2010, 06:43 PM) or variable as over the last 40 years variable has ALWAYS been lower than a fixed rate !

People say this all the time, and its simply not true. Variable is not ALWAYS lower than fixed, variable has been ON AVERAGE lower than fixed, most of the time. It is not the case that at ANY time over the last 40 years, you`d have been better off getting a variable mortgage.

I understand that banks set 5 year fixed at their expectation for variable over 5 years plus a risk premium, but sometimes the markets expectations are too low, and fixed ends up having been a better deal.

For example, according to the Bank of Canada, in January 1978 the average rate on a five year fixed mortgage was 10.32%. Source: http://www.bankofcanada.ca/pdf/annual_page57_page58.pdf

However, for the 5 year period when that mortgage would have been in force, the average prime rate (also according to the BoC) was 16.62%. Source: http://www.bankofcanada.ca/pdf/annual_page...ge50_page51.pdf

So while variable is most often better than fixed, it hasn`t always been better than fixed, for example in January 1978, when those who locked in were better off. I don`t claim to know the right choice now, and I conceed that variable is most often better than fixed, but to say the choice is easy because variable is always better is false. As investors we`re better off rationally considering all the options and making the decision that best fits our individual plan, not just blindly going fixed or variable.

Regards,

Michael

 

[housingrental]

Agreed with Michael`s post above
I`ve recently been given the choice of prime + 2.5% or 5.5-5.7% fixed 5 years.
I`d normally be more inclined to go variable but I wouldn`t be surprised if fixed term outperforms the variable over the next 5 years.

 

[bizaro86]

QUOTE (housingrental @ Apr 22 2010, 09:25 AM) Agreed with Michael`s post above
I`ve recently been given the choice of prime + 2.5% or 5.5-5.7% fixed 5 years.
I`d normally be more inclined to go variable but I wouldn`t be surprised if fixed term outperforms the variable over the next 5 years.

This is a great point. Obviously it depends on the circumstances of the specific loan(s) you are offered. I took a 5 year fixed in 2009 at 3.79%. My other option was a variable at prime+1, which was (and is) 3.25%. So far I`m still behind on taking the fixed, but if rates go up to anywhere near their "normal" levels within the next year or two, I`ll be ahead. We`ll see what happens, but I`m confident fixed was the right choice for me at that time.

Michael

 

[Thomas Beyer]

QUOTE (bizaro86 @ Apr 22 2010, 07:46 AM) People say this all the time, and its simply not true. ...
I like the graphs .. thank you !

However, I do NOT see ANY time period where the fixed rate was lower than prime had you locked in that year ..

late 70`s was also a period of huge baby-boomer induced growth .. s.th. that will not happen again in N-America.

A fixed rate is like buying insurance. On average, you will ALWAYS, ALWAYS pay more with fixed rates. The winners: the banks !

Yes, lock in if you cannot afford a temporary peak to 6 or 6.5% with prime .. but as prime rises prime - X % mortgages will be common again.

Rather keep the savings in a separate bank account for a "rainy" day !

 

[bizaro86]

QUOTE (ThomasBeyer @ Apr 22 2010, 11:19 PM) I like the graphs .. thank you !

However, I do NOT see ANY time period where the fixed rate was lower than prime had you locked in that year ..

Hello,

If you locked in a 5 year mortgage in January 1978, over the life of that mortgage you would have paid much less interest. Because you`d have paid the same rate for 1978-1982. Your five year fixed rate would have been 10.32%.

In January 1978, the prime rate was 8.25%, so you paid a premium over prime to lock in, as you would expect. However, rates went up very fast. By January 1979, the prime rate was 12%, so during 1979, the 10.32% the locked in mortgage holder was paying looked pretty good. By January 1980, prime had gone up even more to 15%, so that 10.32 was looking even better. By January 1981, prime went up yet again, this time to 18.25, and it peaked in 1981 at 22.75%. So the person who locked in in 1978 was paying 10.32%, while those with variable rate mortgages were paying around 20%. The last year of this hypothetical 5 year mortgage, 1982, prime started the year at 16.50 and finished it at 12.5, both higher than a five year fixed locked in in 1978 at 10.32%.

As I mentioned in my last post, the average prime rate during this five year mortgage would have been 16.62%. However, the five year fixed rate available at the beginning of the mortgage was 10.32%. So locking in a fixed rate in January 1978 would have saved money over choosing variable.

Which means that variable has not ALWAYS been cheaper.

Granted that doesn`t happen often, and I`m not saying that`s what will necessarily happen now, but it has happened at least once in the past.

QUOTE (ThomasBeyer @ Apr 22 2010, 11:19 PM) A fixed rate is like buying insurance. On average, you will ALWAYS, ALWAYS pay more with fixed rates. The winners: the banks !

This is true. On AVERAGE, a fixed rate will be more expensive. A fixed rate will NOT ALWAYS be more expensive. There is a difference between --MOST OF THE TIME-- and --ALWAYS-- and that difference is important. I`ve provided Bank of Canada data, demonstrating at least one instance where taking a fixed rate was the better choice (and the difference was substantial).

Michael

 

[gwasser]

QUOTE (ThomasBeyer @ Apr 22 2010, 11:19 PM) I like the graphs .. thank you !

However, I do NOT see ANY time period where the fixed rate was lower than prime had you locked in that year .....

late 70`s was also a period of huge baby-boomer induced growth .. s.th. that will not happen again in N-America.

A fixed rate is like buying insurance. On average, you will ALWAYS, ALWAYS pay more with fixed rates. The winners: the banks !

Yes, lock in if you cannot afford a temporary peak to 6 or 6.5% with prime ......

Rather keep the savings in a separate bank account for a "rainy" day !


The keyword here is: "If you can not afford a temporary peak". Why wouldn`t you be able to afford a somewhat higher interest rate? Simple, you`re probably overleveraged. So, keep your LTVs down. Especially in an rising interest rate environment 90 or 95% leverage is too risky. I prefer 65 to 70%.

Here is the problem: ROI versus positive cash flow! If your leverage is too low your ROI falls back to the normal real estate appreciation rate 6-8% per year while getting oodles of cash flow. If you have an LTV around 80 to 90% you may achieve ROIs as high as 30%. What people forget is that this ROI is on a low down payment thus my saying "a 100% return on nothing is still nothing". On the otherhand, get the returns that are `good enough` and you have cash flow, a buffer against rising interest and less risk. What is wrong with 10 to 15%?

For a conservative and prudent investor it is not a matter of achieving the maximum ROI, but to achieve a good ROI that compares well with that of other investment classes. Problem in real estate is that the ROI also includes your compensation for work, especially when you are the Finder in a JV.

I propose that when you evaluate your next purchase, you include your work compensation in the operating costs of the property. Just like the property manager. It truly estimates what your ROI is compared to other investments and shows whether you are properly compensated for the risks you and your partners take (including LTV risk).

Look at high leverage and `ROI`s this way:

Case one: Net worth $1000,000 with 10% down. Now you can own $10,000,000 in real estate. At an average door price of $100,000 that means you run 100 doors. How much time does it take you to find 100 properties at $100,000 each and then manage them? So your ROI is 30% and that means you are making $300,000 per year. At an average 11.7% historical average stock market return you make $117,000 - of course that is without working. You could live from $117,000 and do nothing or do some other money making work without the fear that a 5% drop in the real estate market would wipe out half your capital.

Case 2. With a net worth of $1000,000 and 50% down you can own $2,000,000. With an average door price of $200,000 you own 10 properties and say the ROI of 15%. You`re making $150,000 per year and you`ll be sleeping a lot better at night. Guess what you also work a lot less hard. In the stockmarket you make $117,000 per year, so for your managing your real estate (assuming a comparable risk level) you`re getting paid for this part-time job $33,000 per year. The rest of the time is yours.

When Don Campbell is talking about lifestyle, family life and being there for your kids, which scenario does he have in mind do you think?

 

[Thomas Beyer]

QUOTE (gwasser @ Apr 23 2010, 08:17 AM)
The keyword here is: "If you can not afford a temporary peak". Why wouldn't you be able to afford a somewhat higher interest rate? Simple, you're probably overleveraged. So, keep your LTVs down. Especially in an rising interest rate environment 90 or 95% leverage is too risky. I prefer 65 to 70%.


true .. keep leverage reasonable .. and even with 20% down cash-flow is VERY HARD to come by, especially after management fees and the odd major expense that seems to creep up from time to time and will for sure over a 5+ year hold !



more here:



Are you too levered ?


..



Here is the problem: ROI versus positive cash flow! If your leverage is too low your ROI falls back to the normal real estate appreciation rate 6-8% per year while getting oodles of cash flow...




indeed .. the difference is wealth creation vs. wealth preservation.



Using 25% down, and no cash flow even .. and using a 25 year mortgage which is being paid down 10% in 5 years you make 40% on your money WITH NO CASH FLOW and NO EQUITY UPSIDE !



Assume a modest 4% upside per year on average or 20% in 5 years and you make over 100% with no cash flow (i.e. assume all cash flow is pumped back into asset)





Two related posts showing detailed numbers with different leverage options:



50 Year house price view: http://myreinspace.com/rein_members_only/Members-Only_Discussion/81-6621-50_Year_Calgary_House_Price_View.html



Equity Gain not the only way to make money in RE: http://myreinspace.com/public_forums/Real_Estate_Discussion/62-10711-Equity_is_not_the_only_way_to_make_money_in_real_estate.html

 

[larysa002]

QUOTE (bizaro86 @ Apr 23 2010, 07:32 AM) If you locked in a 5 year mortgage in January 1978, over the life of that mortgage you would have paid much less interest. Because you`d have paid the same rate for 1978-1982. Your five year fixed rate would have been 10.32%.


I have seen the case in that years when a realtor bought the property for investment, than had to sell in 2 years at a loss of more than $40,000. Her rate was around 18% at that time, and the prices fell. Double disaster.

 

[gwasser]

Here is an `APOD` that instead of `Property Management Fees` assumes the investor does all the work and that this is part of the operating statement. Of course, it will destroy your `Cap Rate` but look at the REAL ROI - that is the real point of this exercise.If you do all the work for a property and you have 10 such properties then on a full time basis wouldn`t you expect to make at least $50K per year? That is what I assumed in this APOD for a condominium where all the exterior maintenance work is taken care of by the condo corp (although you may want to sit on the board to keep a close eyes on things). The condo corp also pays for heating and water&sewer while the tenant takes care of the rest of the utilities (cable and phone). You may also notice that the down payment is 50%. This is needed to maintain positive cash flow. These numbers are based on the current calgary condo market for a 2 bedroom apartment.

• Gross Rent ($1200/mo) : $14,400
• Parking Income : $ 720
• Vacancy & Bad debt (5%) : $- 756
• Effective Rent : $ 14364
  • Property Taxes : $ 982
  • Condo fees : $ 3804
  • Unit Repairs : $ 500
  • My time and work : $ 5000
  • Total Operating Costs : $ 10286

• • • Net Operating Income : $ 4078

• • • Purchase Price : $ 205000Down Payment (50%) : $ 102500Mortgage Payments : $ 4101 (35 yr, 2.05%, variable)
    Net Cashflow : $ - 23 (don`t forget you paid yourself already $5000)

• • 6% Appreciation : $ 12300

• ROI : 14%

• Cap Rate : 2% (don`t forget you paid yourself already $5000 in operating expenses)

In this scenario the ROI is 14% which is close to that of the average stock market return of 11.7% average. Considering the leverage risk, risk of yet lower rents and operating risk, I would think 14% is not entirely unreasonable,

 

[Mecheng]

Hi Godfried, question about your 11.7% average stock market return. Where did you obtain this value?
I know this can be a topic of great discussion between investors, usually depending on the type of investment they prefer.
Some will quote 12% while other will quote as low as 4%. Please excuse my personal rant on this one.

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You can see from the Dow Jones charts on this site that over the last few decades a 10-12% rate of return may seem average or the norm.
(similar to how many people think today`s low interest rates are the norm, see I did include the original topic here)
But looking further back this is not the case, in fact probably much less than 8%, from inception.

Also as it pertains to the individual investor the average is only a measure of the middle or central tendency.
My guess (opinion only here) is small % outperform by a lot and majority underperform by a little.

Take two investors that match the average perfectly and invest the same amount over a 50 yr investment career.
#1 invests in 1932 just after the great depression and finishes in 1982, the dow climbs from 50 to over 1000 during this period.
#2 invests in 1928 just before the great depression and finishes in 1978, the dow climbs from ~400 to just under 1000 in this period.
Just a small shift in timing and the average return they obtain is affected greatly.

I`m not trying to imply that one was timing the market while the other wasn`t, anymore than those that locked in interest rats in the late 70`s knew what was coming. Only that sometimes which side of the historical average we fall on is dependent on our timing (controled or not) and the value you use for that historical average is greatly influenced by the period you chose to look at to obtain your average data.

I actually don`t disagree with your analysis or comparison of RE investment vs. stock market, only that the 14% achieved in the RE investment is actually much higher than that which would be achieved in the stock market. As I said this can be a topic of long discussion and I tend towards the lower returns coming from the stock market for those in diversified portfolios buying and hoping to keep pace with the "average".

 

[gwasser]

QUOTE (Mecheng @ Apr 23 2010, 01:20 PM) Hi Godfried, question about your 11.7% average stock market return. Where did you obtain this value?
I know this can be a topic of great discussion between investors, usually depending on the type of investment they prefer.
Some will quote 12% while other will quote as low as 4%. Please excuse my personal rant on this one.

Visit this Website

You can see from the Dow Jones charts on this site that over the last few decades a 10-12% rate of return may seem average or the ......

I actually don`t disagree with your analysis or comparison of RE investment vs. stock market, only that the 14% achieved in the RE investment is actually much higher than that which would be achieved in the stock market. As I said this can be a topic of long discussion and I tend towards the lower returns coming from the stock market for those in diversified portfolios buying and hoping to keep pace with the "average".



You think too short term. There are extensive studies done on stockmarket performance. I wrote a lot on this on my blog including the statistics you wonder about. Just click on Canadian Diversified Investor below.

 

[bizaro86]

QUOTE (Mecheng @ Apr 23 2010, 01:20 PM) Take two investors that match the average perfectly and invest the same amount over a 50 yr investment career.
#1 invests in 1932 just after the great depression and finishes in 1982, the dow climbs from 50 to over 1000 during this period.
#2 invests in 1928 just before the great depression and finishes in 1978, the dow climbs from ~400 to just under 1000 in this period.
Just a small shift in timing and the average return they obtain is affected greatly.

I`m not trying to imply that one was timing the market while the other wasn`t, anymore than those that locked in interest rats in the late 70`s knew what was coming. Only that sometimes which side of the historical average we fall on is dependent on our timing (controled or not) and the value you use for that historical average is greatly influenced by the period you chose to look at to obtain your average data.

Most stock market investors don`t make their investments in one big chunk. You can think about this logically. The average person investing for retirement (say at 65) doesn`t invest 50,000 at age 20 and then never another dollar, because most people don`t have the ability to invest large lump sums, but rather save money over time.

Most people who invest do it monthly, or yearly during RRSP season or when they get their annual bonus. By investing a bit every year (aka Dollar Cost Averaging) you smooth out the market blips, and make timing much less important. Your hypothetical investor who started in 1928 who continued investing each year into a lower market through the depression, would have ended up with a similar result to someone starting in 1932.

This is an advantage of the stock market over real estate for the small investor. You can invest monthly with a small dollar amount, whereas real estate you need a large downpayment (say 40,000 for 20% on a 200,000 property). That required investment is a large psychological hurdle for most people.

The lack of divisibility is also an disadvantage. It`s pretty hard to sell half a condo if you need money in an emergency, whereas you can sell as little as one share of a stock if necessary.

I invest more of my own money in RE than the stock market, but they both definitely have their pros and cons.

Michael

 

[Mecheng]

I agree that both have their place as I also invest in the market.
The point I was trying to make was when you invest and how the market reacts will drive your return. (Yes, this is also true in RE and beyond our control)
There are several periods of no growth (1966-1983 and recently 1999-2009, start date and end date yield same dow level) where dollar cost averaging into the highs and lows would result in zero return over that period.
If I have 10 yrs 0% return followed by 20yrs at 8% and 20yrs at 12%, I`ll be happy and fondly remembering the last 20 yrs at 12% but you won`t convince me that the market returned 12% on average over my investing career.